Independent contract drilling: Improved revenue and margin can bail out cash flow crisis
ICD has some hiccups
As industry indicators improve, Independence Contract Drilling (ICD) will increase its rig fleets by one notch by 2022. Higher volume coupled with contract renewals at a high daily rate at short term has led to an increase in margin lately. To ICD’s benefit, demand for the 300 series rigs increased due to an emphasis on longer lateral lines and improved hydraulics. So, margin expansion was the resulting by-product.
Despite some of these encouraging signs, the third quarter backlog was disappointing, raising doubts about near-term revenue visibility. At least for the past two years, cash flow has been the ICD’s perennial problem. Recently, management admitted that depressed market conditions could impact its cash flow, forcing it to borrow under the equity line of credit and term loan facility to meet expenses. non-operational required. Between low cash and considerable debt to be repaid by 2023, the balance sheet is not healthy. However, the expected increase in profitability may bail it out in the medium and long term. Thus, investors can hold the stock expecting a stable long-term return.
Platform strategy and outlook
The number of land rigs in the United States increased by 13% during the fourth quarter and remained stable in the first quarter of 2022. The price of WTI crude oil was unchanged in the fourth quarter, but started to increase again in the first trimester. After a lull in the fourth quarter, the price of natural gas started to rise again. While completed wells were flat, DUC wells (drilled by incomplete wells) contracted in the fourth quarter. Thus, the contract drilling industry has seen steady E&P activity, while the decline in the number of DUC wells signals a pick-up in completions activity in the coming quarters.
ICD, for its part, has changed the number of platforms. While it was running with 22 platforms in February 2021, it dropped sharply thereafter. However, in the third quarter, it increased by 23% and exited at 17. Additionally, there was a sequential increase of approximately 8% with the daily rate on contract roles, as efficiencies from a larger base of operating rigs profited at the daily rate. Learn more about the company’s operations in my previous article here.
So in the fourth quarter, the company expects revenue per day to improve sequentially between 7% and 8%. The drill margin per day can improve between 30% and 40% in Q4 compared to Q3. As the impact of full repricing takes effect, he expects current daily spot market rates to continue to evolve, resulting in a 20% to 21% improvement in daily revenue. in the first quarter of 2022 compared to the third quarter of 2021. SG&A expenses in the fourth quarter of 2021 are expected to be flat Q3.
Q1 2022 margin per day may improve between 105% and 110%. Given that daily margins are higher than pre-pandemic reports, management believes this is the start of a bull cycle. Operating days in Q4 increased by 9% compared to Q3, which includes the reactivation of the 16th platform in October. It would activate the 17th platform by the end of 2021.
Forecast of key metrics
By the end of 2021, the company plans to operate 17 rigs, of which approximately 40% would be advanced 300-series rigs with higher daily revenues than in the third quarter. Demand for 300 series rigs is increasing due to the emphasis on longer lateral lines and improved hydraulics. At least six of these platforms will generate incremental revenue and margin improvement per day in 2022. Strategically, with the declining availability of super-specification platforms and the expected increase in revenue and margin per day, natural gas supply and demand fundamentals and weak DUC inventory will set the stage for a long-term market recovery.
In Q1 2022, rig operating days may increase by 9% compared to Q4 2021. Average revenue per operating day may increase by 7% (at the midpoint of the forecast). On the other hand, the cost per day may remain unchanged, leading to a 37% increase in the average drilling margin per operating day in the first quarter.
Q3 Driver Analysis
From Q2 2021 to Q3 2021, the company’s platform operating days increases by 18%. Daily rates have increased as contract renewals have increased due to the short term nature of rentals. Demand for 300 series rigs has increased because upstream companies are now focusing on longer lateral lines and improved hydraulics. ICD plans to reactivate six of the following seven 300 series machines. I believe that the turnover and the daily margin of the company will improve thanks to the reactivation.
Despite higher utilization, costs per day increased sequentially in the third quarter due to higher labor costs coupled with higher compensation per field. As of September 30, the company’s drilling backlog stood at $19.7 million, which is significantly lower than in the past, on average. A lower backlog represents less revenue visibility in the future.
What is the current financial state?
During 9M 2021, ICD’s operating cash flow was -$7.7 million, a significant decrease from a year ago. Lower revenue year over year (down 36%) resulted in a negative CFO. The company’s free cash flow (or FCF), which was already negative a year ago, dipped into deeper negative territory in 9M 2021. In Q3 10-Q, the company disclosed that market conditions depressed can have an impact on its cash flow. It may draw funds from the line of credit and draw funds from the term loan facility to meet required non-operating expenses.
As of September 30, ICD had approximately $140 million in debt, which will need to be repaid in 2023. Its leverage ratio now stands at 0.66x, which is below the average of its peers (NBR, HP, PTEN). Its cash position was $31 million as of September 30, 2021. At the end of the third quarter, the company completed the ATM program (a stock distribution agreement first signed in June 2020) and raised a additional proceeds of $5.4 million at an average price of $3.41 per share.
It should hedge against any significant decline in cash flow and fund the ongoing platform reactivation program. Debt repayment risks will prevail in the medium term without further refinancing or asset sales.
What does relative valuation involve?
ICD’s current EV/EBITDA multiple (1.3x) versus future EV/EBITDA multiple expansion implies a significant decline in EBITDA over the next four quarters. Over the past five years, the average EV/EBITDA was 10.9x. Thus, the company is trading at a steep discount to its past average.
The stock’s EV/EBITDA multiple is below the average of its peers (NBR, HP and PTEN) of 23.7x. Sell-side analysts expect the company’s EBITDA to decline instead of an increase in EBITDA for its peers over the next four quarters, which will generally result in a significantly higher EV/EBITDA multiple. lower than that of its peers. Although the stock price has fallen over the past six months, it may still be relatively overvalued at the current level. It has room for further decline before the fundamentals take over and the stock rallies quickly.
Target Price and Analyst Rating
According to data provided by Seeking Alpha, none of the sell-side analysts have rated ICD as “bullish” in the past 90 days. Only one analyst on the sell side rated it as “neutral,” while none recommended “bearish” or “very bearish.” The consensus target price is $7.0, which gives a yield of around 86% at the current price.
What is the plug on the ICD?
Rising rig counts, post-COVID re-emergence and fiscal freedom for upstream operators in 2021-22 will continue to entice drillers. Under these circumstances, Independence Contract Drilling will strengthen its rig fleet over the coming quarters. Thus, efficiencies crept into sequentially increasing the daily rate on contract roles from a larger operating rig base. All of this means that the company will improve its operating margin in the coming quarters.
Despite some of these encouraging signs, the order book from the fall in the third quarter has eroded, raising doubts about near-term revenue visibility. Recently, management admitted that depressed market conditions could impact its cash flow, forcing it to draw even more from its balance sheet to meet required non-operating expenses.
During the third quarter, it raised proceeds at an average price of $3.41 per share, lower than its current price. This shows management’s lack of confidence in the current market valuation. For example, the stock has underperformed the VanEck Vectors Oil Services (OIH) ETF over the past year. Investors with a risk appetite might be looking to ride the tide for healthier long-term return.